- Several ‘myths’ about the legal underpinnings for special purpose acquisition companies (SPACs) have influenced the perceived costs, benefits and risks of the so-called blank-check companies and distorted capital markets, according to John Coates, acting director of the Securities and Exchange Commission’s Corporation Finance Division from February until October 2021.
- SPAC promoters have made many groundless claims, including that the SEC changed SPAC accounting rules last year and that traditional initial public offerings (IPOs) are slower than SPACs to complete the SEC registration process and, unlike SPACs, cannot provide projections, according to Coates, a Harvard Law School professor.
- “By repeating continuously these myths, the professionals repeating them are attempting to make [it] more likely that they will generate rents in future SPAC deals,” Coates said in a paper.
Despite sharper SEC scrutiny and a mid-year lull in activity, SPACs in 2021 brought to market 613 offerings and raised more than $162 billion, which exceeds the combined total of all previous years, according to SPACInsider. Among IPOs last year involving U.S.-listed exchanges, a record 61% were SPACs.
SEC Chair Gary Gensler has repeatedly expressed concern that SPACs pose risks to investors, saying in May that the agency will investigate how the shell companies raise cash from the public and merge with target companies.
“I believe the investing public may not be getting like protections between traditional IPOs and SPACs,” Gensler said in a Dec. 9 speech, noting a need for more disclosures to investors and protections against fraud and conflicts of interest.
A SPAC has been perceived to be a faster, cheaper way to raise money than through a conventional IPO (C-IPO). It sells shares listed on a stock exchange and then merges with a private company, usually within two years, in a so-called de-SPAC transaction.
SPAC promoters propagate a fiction that the SEC registration process is slower for C-IPOs than for SPACs, Coates said. A SPAC issuer cannot find a short cut through the SEC review process, and will face scrutiny of its disclosures very similar to that applied to those submitted by other IPOs, he said.
Coates identified, and sought to debunk, other ‘myths,’ including:
- The SEC permits SPACs — but not traditional IPOs — to make projections and forecasts.
“There is no law or regulation barring use of projections in C-IPOs,” Coates said. “In fact, some C-IPOs do include forecasts of cash flows.”
- Any liability related to projections is lower for SPACs under the Private Securities Litigation Reform Act (PSLRA).
“It is simply a legal myth to assert that the PSLRA simply does not cover de-SPACs,” Coates said.
- The SEC changed SPAC accounting rules in early 2021.
SPAC promoters have suggested that guidance from SEC staff last year that SPACs account for their warrants as liabilities rather than equity constituted a change in securities law, Coates said.
Yet “the warrant accounting standards dated back to public accounting consultations starting more than 30 years earlier,” he said.
The myth “was in service of downplaying the lack of care apparently exhibited by professionals working on SPACs,” Coates said. “If enforcement of existing law were instead seen as a ‘change,’ the failure to adhere to existing standards could be attributed to the failure to anticipate regulatory change and not simply to failure to know or apply existing standards.”
- The SEC slowed SPAC activity in early 2021.
“This myth is designed to help promote the SPAC market by blaming negative feedback from poor financial returns on unpredictable regulatory forces,” Coates said. As the Corporation Finance Division’s acting director at the time, “I can personally attest that there was no concerted effort to slow SPACs down.”
- SPACs are indisputably not investment companies.
A lawsuit filed in August claims that some SPACs are investment companies, rather than operating companies aimed at merging with a target firm, and should be subject to the rules under the Investment Company Act of 1940.
The lawsuit prompted more than 55 law firms to release a public statement asserting that there is no factual or legal basis for saying that SPACs are investment companies.
Coates disagrees. “SPACs in their first phase function, economically, like mutual funds — a type of investment company.”
The myths “distorted capital market activity for long enough to constitute an example of a type of meaningful informational ‘friction,’ at odds with the presumption that publicly available information will be rapidly reflected in capital asset market prices,” Coates said.
By upholding myths, SPAC promoters “are engaged in a type of ‘deep fraud,’ akin to the ‘big lie’ of political propaganda,” Coates said. “The fraud is ‘deep’ because it does not directly elicit money from deceived strangers — its effects are general, indirect, insidious, downstream.”